There are, alas, only two instruments that a government has to tackle a negative or a positive bubble – monetary and fiscal. Alas, also, the Indian authorities seem to be only aware of positive asset bubbles.

 They will come out with noises, and policies galore, when they want to put the brakes on. Stock prices going up - increase tax rates. Property prices going up - increase interest rates. Money supply growth accelerating - increase the CRR. Bank credit going up - increase the SLR. Inflation rate going up - increase both tax rates and interest rates. GDP growth accelerating - put on new cesses, increase corporate tax rates, put on new surcharges, and increase interest rates. This is not a made up movie but reality under the UPA government and the RBI for the last five years, and especially last year.

So now that the world economy has fallen off a cliff, and we are teetering at the edge, what does the government and the RBI (hereafter the Authorities) do? But you might ask, as the Authorities keep asking, what is the evidence that we are at the edge? Let us look at industrial production. Regardless of whether we look at year on year figures, or whether one looks at growth in seasonally adjusted data, India would be lucky to have more than 2 percent growth in industrial production for the fiscal year 2008/9. Even agricultural growth is down to 2.6 percent from 4.9 percent the year before. So the Authorities should not need proof that the economy has slowed down considerably.

But what about inflation? The Authorities need to realize that a major problem facing this economy, and the world, is deflation, NOT inflation. Evidence? Consider the following: For the ten months April 2008 thru Jan 2009, WPI inflation has registered 2 percent. For the last six months, prices have been falling at an annualized rate of 6 percent! The CSO came out with its GDP estimates a week ago. They provide an estimate of GDP deflator inflation of 7.8 percent for the entire fiscal year. But inflation for the first six months was already at 15 percent annualized or 7.5 percent for the full year. So the Authorities own data experts are estimating that GDP deflator inflation for the six month period Oct 2008 to March 2009 would be ZERO.

This has never happened before in India i.e. that for six continuous months, overall inflation in the economy would be zero. I think the evidence of a growth and price slowdown is there and the only way one can miss it is if one is a deer frozen by headlights on a desolate highway. (What happens to such animals - they die in an accident). Given that there is a crisis, a deep crisis, and that there is a negative bubble of mammoth proportions, what should the government do? Well, policies should go in reverse, reverse of a positive bubble. That means interest rates and tax rates should be cut aggressively, and public expenditures increased. Let us examine what the Authorities have done so far.

Interest rates: The RBI can now take on the mantle of being the worst central bank in the world, a title owned, until recently, by the European Central Bank. It has cut interest rates from 9 to 5.5 percent, but it has not noticed that the inflation rate has fallen even faster. Which is why the RBI is (strangely) pleased by its own actions of cutting the repo rate by 350 basis points in 3 months - during that same period, inflation has fallen by a 1000 basis points. No one (maybe I speak in haste because there maybe RBI experts who believe differently) thinks inflation is a problem today. Which means inflation expectations are down, way down. Even if a liberal 2 percent inflation rate is assumed, corporates and individuals are borrowing at 10 to 15 percent real, the highest in the world, and the highest by orders of magnitude.

Tax cuts: Like the RBI, the sister authority (Ministry of Finance) has cut excise and custom duties. What has been the magnitude of these tax cuts? Relative to the budget estimate of tax revenue of 255,000 crores, made in Feb. 2008, actual excise and customs tax collections are down by Rs. 40000 crores or 0.7 percent of GDP. About half of it is down because of real activity being down, so net stimulus: Rs. 20,000 crores.

Expenditure Policy: So many stimulus packages - total expenditures have increased by Rs. 150,000 crores. This is where seemingly the Authorities have acted. However, about Rs. 60,000 crores is the amount spent extra on food and fertilizer subsidies, and since almost all of this extra subsidy was incurred prior to October 2008, the Centre cannot claim this as stimulus. Another Rs. 25,000 crores is on account of the loan waiver for farmers, which was not part of the above the line Budget in Feb. 2008. It is now part of the budget. Hence, Rs. 85,000 crores of the extra expenditure has nothing to do with government action in response to the crisis. Which leaves only Rs. 65,000 crores of stimulus expenditure. Total action on the part of the government: Rs. 85,000 crores (65 plus 20) or only 1.6 percent of GDP. And this when the fiscal gods at IMF are arguing that countries should spend at least 2 percent of GDP!

But the Authorities say - you are missing out on the extra stimulus of Rs. 100,000 crores in below the line oil and fertilizer subsidies. But their protests are in error, huge error. These subsidies are payment to foreigners for imports, and hence constitute a drag on the economy, a negative stimulus if you will.

So one is left with the worrying conclusion that the Authorities are unaware or misguided or both. Maybe harsh, but no one said truth cannot be bitter. Further evidence on its ineptness can be gleaned from the government forecast of inflation for next year - 4 to 5 percent. This is the average Indian inflation for the last five years when GDP was growing at 9 percent and, according to the Authorities, overheating. The same inflation forecast when the world has collapsed and we are on the edge? Either the Indian government, or the rest of the world, is smoking what they shouldn't.